Europe is heading back into lockdown, but when travel resumes, these are the 3 European airline stocks to own, Morgan Stanley says

  • Despite many European countries facing new lockdown restrictions, Morgan Stanley in a note on Tuesday said it remains “cautiously optimistic” about a gradual return to travel.
  • Morgan Stanley’s equity analyst Carolina Dores breaks down the four reasons why demand for travel is still present and the 3 European airline stocks to buy to capitalize on pent-up demand and a travel recovery.
  • “The International Air Transport Association demand estimates are more positive for intra-EU than long haul,” Dores said – European airlines are best positioned for this form of recovery.
  • Morgan Stanley also outlines selling opportunities of airline stocks that could rally on positive travel news.
  • Visit Business Insider's homepage for more stories.

Many European countries are facing a "second wave" of coronavirus cases. The United Kingdom and certain cities in France, Germany and Spain have implemented tighter restrictions following the rise in cases.

While many in Europe face some form of restriction on movement, some investors are looking to capitalize on the current environment to secure airline stocks at a discount.

Morgan Stanley is expecting a gradual return to flying. In a note on Tuesday, Morgan Stanley equity analyst, Carolina Dores, outlined for investors the best European airline stocks positioned for recovery.

"However, given the recent round of very negative newsflow on increased quarantine restrictions in the UK and Europe, and sharp capacity revisions for winter 2020/2021, we think short term earnings expectations are low," Dores said, "We see some room for (cautious) optimism."

This cautious optimism comes from two factors: testing and vaccinations. 

Dores said testing in airports could "marginally improve travel restrictions." Frankfurt airport was testing around 5% of normalized passengers per day, according to 2019 passenger number data. The implementation of testing helped in the slow restart to travel demand in Germany during the summer. 

If governments agree to allow testing to reduce quarantine periods then there could be an uptick in demand, Dores said. 

And while testing could kickstart gradual travel demand, a vaccine could move society toward a full recovery.

The Morgan Stanley BioPharma and European Strategist teams expect positive announcements on vaccines toward October or November and believe mass vaccinations programs could start as early as first quarter in 2021 in developed markets. 

News of a vaccine could lead investors to start focusing on recovery stocks like airlines.

"If newsflow were to shift towards a recovery of travel demand, we think investors would increase their focus on upside from recovery," Dores said. "We see travel restrictions as a significant barrier to demand. Once these are lifted, we think there is pent up demand for travel."

Morgan Stanley believes demand is still high for travel

Morgan Stanley believes there is still high demand for travel based on four reasons:

  • "Consumer surveys indicate  no long term damage to consumers' willingness to travel"

"Our latest AlphaWise survey has shown that respondents' long term travel plans have not been impacted by Covid," Dores said.

  • "The International Air Transport Association demand estimates are more positive for intra-EU than long haul"

Demand is expected to return sooner for intra-european traveling, so investors should consider companies that specialize in European routes.

  • In countries where travel restrictions have been lifted, demand rebound has been strong.

"If we look at the Chinese domestic market, demand is approaching 2019 levels already," Dores said. "And in the US domestic market, before infections rates increased, we saw that demand bounced back very quickly once restrictions were removed."

  • Airlines need to trim capacity

In a post-covid world, airlines will need to work on repairing their balance sheets, which will likely mean reducing capacity and lowering capital expenditures. This will create a favourable environment for airlines with strong cash positions, Dores said.

Read More: A Wall Street expert explains why the market's ongoing turbulence could end within 2 weeks — and pinpoints 3 stocks to grab cheaper now as big investors buy the dip

Morgan Stanley recommends these airlines

Investors looking to capitalize on the gradual recovery and pent up demand should consider these three stocks:

RyanAir (RYA)

Morgan Stanley has rated RyanAir, Europe's largest budget airline, overweight with a price target of €16.00. The overweight rating is based on three factors:

  • RyanAir's large liquidity resources will be an advantage as the industry recovers.
  • The delayed delivery of Boeing's 737 Max was previously seen as an impediment to RyanAir's growth by Morgan Stanley. Now it's seen as an advantage.
  • "Under our base case, we do not think RYA would need to strengthen its capital via an equity raise, which is a strong position relative to peers, assuming demand rebounds in 2021," Dores said.

Wizz Air Holdings Plc (WIZZ)

Morgan Stanley has rated Hungarian low-cost carrier Wizz Air Holdings Plc overweight with a price target of £45.00. The overweight rating is based on four factors:

  • Wizz airlines has a solid position in central and Eastern Europe as well as strong connectivity in Western Europe. 
  • "Large liquidity reserves and flexible cost structure allow Wizz to have over 12 months of liquidity even assuming full grounding," Dores said.
  • Morgan Stanley thinks Wizz can grow above market and deliver its capacity growth plans even during a slow recovery.
  • "We see potential from cost base flexibility to boost confidence in the earnings outlook as the company grows scale," Dores said.

EasyJet Plc (EZJ)

Morgan Stanley has rated London-listed EasyJet Plc equal weight with a price target of £8.00. The equal weight rating comes from Morgan Stanley's estimations that EasyJet's liquidity is below its peers. EasyJet has only 10 months of liquidity versus the 17 months for RyanAir and 14 months for Wizz. 

Dores also expects growth opportunities to be slower for EasyJet compared to other low-cost airlines in Europe.

"EasyJet has opted to take a more conservative route and has reduced capacity for the coming years. Based on the current fleet plan, easyJet recovery should be slower than peers," Dores said.

But if demand recovers more quickly than Morgan Stanley's base case, then EasyJet could be a trading opportunity, Dores said.

"But if demand comes back faster than we anticipate, we think shares could rally, and think [EasyJet] offer a better risk reward than LHA and AF," Dores said.

Morgan Stanley rates high beta airlines underweight

Morgan Stanley does not believe now is the time to consider high beta airlines such as Deutsche Lufthansa AG (LHAG)  and AirFrance-KLM (AF), which are currently rated underweight.

Neither of these airlines will face liquidity issues through the winter, but with demand for long-haul flights remaining weak, the companies could face higher losses. Morgan Stanley expects  the companies to face restructuring requirements and likely capital increases.

"While we think the stocks could rally on more positive news (e.g. reopening of the transatlantic routes), we would see these events as selling opportunities," Dores said.

Read More: Legendary trader Randy McKay turned $2,000 into $70,000 in just 7 months. Here are the 8 trading rules that contributed to his multiyear run of million-dollar returns.

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